A Strong Core Keeps the Euro Flexible

By Nicholas Hastings

Like a well-trained athlete, the euro is once again showing the importance of having a strong core.

Without one, the single currency would no doubt be tumbling.

This latest display of the strength at the heart of the euro has come as economic data in the euro zone have deteriorated, speculation over a rate cut has increased and the decision by Italian Prime Minister Mario Monti to resign has sent the regions’ third-largest economy into a political spin.

But the euro’s performance has been remarkable.

As Italian bond yields have tumbled and Italian stocks have taken a beating, the euro has essentially sailed on through. After backing back down under $1.30 late last week, the single currency appears to have settled into a range around $1.29.

This performance is particularly notable as it comes after several weeks of economic data showing that the slowdown in the poorer debtor countries of the euro zone is now spreading to the core countries, such as Germany.

The impact that the decline in demand in the euro zone is having worldwide was illustrated over the weekend by the latest trade data from China, showing a sharp drop in exports.

By the end of last week, financial markets were rife with rumors that the European Central Bank, which had only just decided not to cut interest rates on Thursday, would probably do so at its next meeting in January.

But even this rate-cut talk wasn’t enough to seriously damage the euro.

Why?

Because of the single currency’s strong core.

This means that when the news of Mr. Monti’s planned resignation broke and financial markets started to speculate Monday on what this means for Italy’s ability to continue its fiscal reforms, investors moved out of Italy but they weren’t moving out of the euro zone.

In fact, as they have done in the past, investors simply moved into the core countries, Germany and France, pushing the yields of key benchmark issues in France to a new record low and those in Germany very close to it.

In other words, despite the economic slowdown, despite the worries about Germany heading into the recession and despite the higher borrowing costs that Italy will now have to burden, investors remain confident in the euro’s core.

How long this will last remains to be seen.

But it all suggests that the economic ills starting to affect Germany will probably not affect the euro itself just yet and that the single currency will probably remain resilient until there is another serious threat of a euro-zone debtor being forced to default.